Fixed rate home loans...

To fix, or not to fix?

Written by Michael McAlary

In managing home loan debt it’s always important to take an active approach. Specifically, home loan borrowers should stay abreast of interest rates and where the markets believe they are going. This is critical as it could save or cost you thousands of dollars, if you make the right or wrong decision to fix.

There are some key rules that home loan borrowers should remember. These are:

• Fixing your loan may provide the long term security of consistent repayments but rates may continue to fall, reducing any benefit
• Be careful when setting the term of any fixed period as the costs associated with breaking a fixed loan (economic costs) can be expensive
• Fixed term loans generally limit your ability to make additional repayments
• All lenders offer the ability to fix a portion of your loan i.e. part variable/part fixed. If unsure whether to fix, this allows you to hedge your bets

What is a yield curve?

The yield curve is a line that starts with today’s cash rate and plots all market rates, (e.g. 90 day bank bill swap rate) to longer dated interest rates, e.g. 10 year Australian Government Securities (bond rate).

When is a good time to fix?

• If the yield curve is positive, i.e. the cash rate is lower than the 10 year Australian Government Securities (bond rate) then the market expects interest rates to rise, i.e. home loan interest rates will likely increase
• If the yield curve is negative, i.e. the cash rate is higher than the 10 year Australian Government Securities (bond rate) then the market expects interest rates to fall, i.e. home loan interest rates will likely decrease
• If the yield curve is flat, then the market does not know the direction of interest rates

The Reserve Bank of Australia has been reducing interest rates; however there will come a point in the economic cycle when it will stop doing so, increasing the probability of a cash, then home loan rates rise.

In determining whether to fix your home loan, it is important to consider where in the economic cycle interest rates are, in relation to the yield curve. If it’s negative then rates could fall further, but be careful as the banks may only reduce their variable rate and not their fixed rate loans.